AP Macroeconomics Question 365: Answer and Explanation

Test Information

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Question: 365

12. The economy is currently operating at full employment. Assuming flexible wages and prices, how would a decline in aggregate demand affect GDP and the price level in the short run, and GDP and the price level in the long run?

SHORT-RUN GDP     SHORT-RUN PRICE LEVEL     LONG-RUN GDP     LONG-RUN PRICE LEVEL

  • A. Falls     Falls     No change     Falls
  • B. Falls     Falls     Falls     Falls
  • C. No change     Falls     No change     No change
  • D. Falls     Falls     No change     No change
  • E. Falls     Falls     Falls     Falls

Correct Answer: A

Explanation:

A-If prices and wages are flexible, the long-run economy readjusts to full employment. Falling AD lowers the price level and real GDP in the short run, but eventually lower wages shift the short-run AS curve to the right, further lowering the price level and moving long-run production back to full employment.